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A freeze in lending triggers a panic in a Western financial capital which then spreads around the globe, eventually tipping several South American countries into default. In a desperate attempt to stem the panic, the central bank steps in as "the lender of last resort" and unleashes a flood of new money into the palpitating financial system.

Gee, was that 1998, or 2008? Neither -- try 1825 London.

You might think an era of gas lighting, slow sailing ships and horse-drawn carriages has little to teach us about modern finance, but much of what we consider advanced capitalism has been in place since the 1500s: stock markets, portfolio insurance, options, commercial paper and global banking.
Eerily, many of the conditions that fed the boom of the 1820s and the bust of 1825 parallel the present:

New financial instruments had been introduced which obscured both risks and returns.

The academic phrase for this gulf between what the seller of the security or property knows -- that it is hugely risky -- and what the buyer accepts as true -- that this is a "safe" investment with a satisfactorily high return -- is "asymmetric information."

Many analysts point to the prodigious expansion of difficult-to-assess mortgage backed securities and exotic derivatives such as CDOs (collateralized debt obligations, often backed by highly leveraged securities) as the chief source of asymmetric information flow which caused buyers around the world to purchase highly risky assets in the belief that they were high-yielding "safe" investments.

Others point to the ample opportunities for fraud and embezzlement in such cloudy situations -- another parallel with 1825 and indeed, every stock market/credit bubble and subsequent crash.

It is generally overlooked that capitalism in its natural state is highly prone to bouts of credit expansion and euphoric speculation which then lead to financial panics and crashes. The Panic of 1825, for instance, was followed by the panics of 1837, 1847 and 1857. Then next crash, in 1866, was hardly the end of volatility, as the Panic of 1873 was a real doozy, setting off a deep six-year recession in the U.S. The Panic of 1893 is generally considered to have launched a depression, while the Panic of 1907 is widely credited with sparking the creation of the Federal Reserve system six years later in 1913.

The central purpose of the U.S. Treasury and the Fed's interventions has been to prop up the banking system, with the understanding that it was necessary because banks perform the essential services of processing private information (mortgage applications, for example) and monitoring borrowers.

But what the Fed and Treasury have not learned from the Panic of 1825 is that the shareholders and managers of the banks which were saved from insolvency by central bank intervention should suffer the losses which are necessary to encourage prudent lending after the panic has ended.

The Fed and indeed, all the central banks of the major global economies, also failed to understand the chief lesson of the 1825 Panic: that it was fundamentally fueled by expansionist monetary policy.

Thus we have to wonder if the current central banking "solution" -- encouraging lending, lowering interest rates and accepting any sort of distressed asset as collateral -- isn't just setting up the Panic of 2011.